Texas Instruments (TXN) Q4 2013 Earnings Call January 21, 2014 5:00 PM ET
Ron Slaymaker – VP, IR
Kevin March – SVP and CFO
John Pitzer – Credit Suisse Securities
Doug Freedman – RBC Capital Markets
Christopher Danely – JPMorgan Securities
Blayne Curtis – Barclays Capital
Stephen Chin – UBS Securities
Timothy Arcuri – Cowen & Co.
Jim Covello – Goldman Sachs
Ambrish Srivastava – BMO Capital Markets-US
Vivek Arya – Bank of America Merrill Lynch
Tore Svanberg – Stifel Nicolaus
Ross Seymore – Deutsche Bank
Good day, and welcome to the Texas Instruments Fourth Quarter and 2013 Year-End Earnings Conference Call. At this time, I'd like to turn the conference over to Ron Slaymaker. Please go ahead, sir.
Good afternoon, and thank you for joining our fourth quarter and yearend earnings conference call. As usual, Kevin March, TI's CFO, is with me today. For any of you who missed the release, you can find it and relevant non-GAAP reconciliations on our website at ti.com/ir. This call is being broadcast live over the web and can be accessed through TI's website. A replay will be available through the web.
This call will include forward-looking statements that involve risks and uncertainties that could cause TI's results to differ materially from management's current expectations. We encourage you to review the Safe Harbor statement contained in the earnings release published today, as well as TI's most recent SEC filings, for a more complete description.
The fourth quarter was a good one and wraps up a good year. We are entering the first quarter of 2014 feeling better than we did entering the first quarter of 2013. Before I review the quarter, let me provide some information that is important to your calendars.
Starting this quarter, we will not be providing a mid-quarter update to our outlook. Our business is now sufficiently diverse across markets and customers that we believe a mid-quarter update is no longer necessary. The diversity in our business means that TI’s results should mostly reflect broader industry tech trends as opposed to TI’s specific considerations such as adjustments in demand from a large customer. In fact, in our last eight updates, we narrowed to the middle of the range six times on a revenue basis.
We do plan to hold a call on March 13 to update you on our capital management strategy. This will be a follow-on to the call we did a year ago on this topic. In this call, Kevin March will provide insight into our strategy and also answer some of the most frequent questions that we are asked about this strategy. More details will be forthcoming.
Revenue in the fourth quarter was in the upper half of our range of expectations. Once again cash generation and returns remained strong. Free cash flow was $3 billion or 24% of revenue for the trailing 12 months period, or in this case, the full year of 2013. Over that same period, we returned over $4 billion of cash to investors through a combination of dividends and stock repurchases. This return was 136% of free cash flow for the year. Again our strategy is to return all of our free cash flow to our shareholders except what is needed to repay debt.
EPS was at midpoint of our range. However it also included $0.03 of charges for a restructuring action that was not previously included in our guidance. So overall a good quarter.
The restructuring that is underway is a result of our ongoing assessment of our investments and the market opportunities that we are addressing with those investments. First, we are reducing costs in certain embedded processing product lines that either have matured or do not offer the return opportunities we are looking for. These changes will accelerate a profit margin improvement in the embedded business while still maintaining its pace of growth.
Of note that we are not exiting any markets or discontinuing any existing products but are aligning resources consistent with our updated views of the market opportunities.
We are also lowering costs in Japan by reducing resources in that country to levels that are appropriate to the opportunity. Combined, these actions are expected to result in annualized savings of about $130 million by the end of 2014. As a result of these actions, we will eliminate about 1100 jobs.
Total charges are estimated to be about $80 million where $49 million included in the fourth quarter results and the remaining charges of about $30 million to be included in the first quarter. These charges are recognized in the other segment.
In the fourth quarter results, TI revenue grew 2% from a year ago. Excluding legacy wireless, revenue grew 10% with double digit growth in both analog and embedded processing. Sequentially, revenue declined 7% with half of the declines due to seasonally lower calculated revenue.
Analog revenue grew 12% from a year ago and declined 3% sequentially. From a year ago, all four major product lines were up with power management leading the growth. Sequentially, all major product lines were down with high performance analog declining the most.
Embedded processing revenue grew 11% from a year ago and declined 10% sequentially. From a year ago, the growth was due to strengthened micro-controllers. Connectivity revenue grew a single-digit percentage rate and processors were about even. Sequentially, all areas were down with the biggest decline in processors.
In our other segment, revenue declined $209 million or 27% from a year ago. The decline was due to legacy wireless dropping $216 million. Sequentially, other revenue was down $90 million due to the seasonal decline in calculators. Legacy wireless revenue was $54 million in the fourth quarter and we expect it to be essentially gone in the first quarter.
Turning to distribution. Resales declined 3% sequentially, trending about the same as our semiconductor product revenue. Distributors’ inventory levels were about even with the prior quarter.
Let me make a couple of observations about the year overall. For 2013, analog and embedded processing revenue grew a combined 4% with analog up 3% and embedded up 9%. These two key areas were 79% of TI revenue for the year, up from 72% in 2012.
Operating margin for analog was 25.8% and it exceeded 30% during the second half. Operating margin for embedded processing was 7.6%, a level that should increase as we continue to grow and as we execute our restructuring plans to better align resources with the opportunities that we are pursuing.
Finally, we are refining descriptions of our end market mix to more closely match our perspective of our markets and investments. Traditionally, we and many other companies have described the markets as communications, computing, industrial, consumer, automotive and education. The real world didn’t always align so cleanly and some of the categorizations became blurred. For example, consumer smartphones were included with infrastructure equipment in the communications market and consumer tablets were included with servers in the computing market. In both of these examples, high volume consumer products were grouped together with enterprise equipment that have very different life cycles and market characteristics.
We believe our revised segmentation is more description and reflective of the markets we sell into and therefore more helpful for our understanding of our business. Starting now we will provide an annual snapshot of our product mix along the following market descriptions. Industrial which is 24% of revenue in 2013; automotive which was 13% of revenue; personal electronics which was 37% of revenue and include subsets which we call sectors such as notebooks, tablets, mobile phones and consumer products.
Communications equipment which was 16% of revenue; enterprise systems which include sectors such as servers and projectors was 6% of revenue; and calculators which was 4% of revenue. We have matched [ph] our product revenue in these markets as well as the sectors and even in the equipment levels below that, we find this especially beneficial for the industrial markets where the market definition has historically not been very clear and where we have a strong strategic focus.
We now have a reasonably precise profile of where our revenue is shifting that is more accurate than we’ve had in the past. We’ve included on our website this 2013 product revenue breakout by market along with the 2011 and 2012 historical breakouts. We’ve also identified the sectors below the markets provide you a clear understanding of how we are mapping the revenue. We will not be disclosing our revenue breakout below the market level. We plan to update this for you annually.
Now Kevin will review profitability and our outlook.
Thanks, Ron, and good afternoon, everyone. Gross profit in the quarter was $1.64 billion, or 54.2% of revenue. Gross profit declined 8% sequentially – about the same as the 7% decline in revenue. Gross margin held up very well, slipping only 60 basis points from last quarter’s record high.
From a year ago, gross profit was up 13% – well above the 2% increase in revenue. The result was a 570 basis point expansion in gross margin. There are a couple of major reasons for gross profit expanding significantly faster than revenue.
First, the quality of our portfolio has improved as the higher proportion of our revenue is from Analog and Embedded Processing products. Second, our factory utilization has improved as we have increased loadings in our most advanced factories and we have shut down older, less-efficient manufacturing assets, such as our Houston and Hiji 6-inch factories.
Moving to operating expenses. Combined R&D and SG&A expense of $807 million was down $26 million sequentially and down $48 million from a year ago. The sequential decline is mostly due to seasonality, as employees typically take more vacation and holiday time in the fourth quarter. The decline from a year ago was due to the wind down of our legacy wireless products.
Acquisition charges were $84 million, almost all of which is the on-going amortization of intangibles, a non-cash expense.
Restructuring and other charges were $62 million. This included a $49 million charge for the restructuring action that Ron discussed. This was not included in our prior guidance and negatively impacted earnings by $0.03 per share.
Operating profit was $687 million, or 22.7 % of revenue. Our tax rate in the quarter was 25%, a point above the 24% that we had guided. The effective tax rate remained 24% but we had several small discrete items that pulled the rate up in the quarter.
Net income in the fourth quarter was $511 million, or $0.46 per share.
Let me now comment on our capital management, starting with our cash generation. Cash flow from operations was $1.20 billion in the quarter. We increased our inventory by $5 million compared with the prior quarter. Inventory days increased by 6 days to 112 days, consistent with our model of 105 to 115 days.
Capital expenditures were $107 million in the quarter. I should note this includes our purchase of a 358,000 square foot assembly and test facility in Chengdu, China, that is adjacent to our existing wafer fab. We expect to have this facility equipped and in production by the fourth quarter of this year.
On a trailing 12 months basis, Cash flow from operations was $3.38 billion. Trailing 12 months capital expenditures were $412 million, or 3% of revenue. As a result, free cash flow was $2.97 billion, or 24% of revenue. This is within our expected range of 20% to 25% of revenue.
I’ll note that depreciation expense for the full year was $879 million. Depreciation exceeded our capital expenditures by $467 million, or 3.8% of revenue. Over the next few years, as we continue to hold capital spending to low levels, depreciation will decline to the rate of capital spending and our gross margin will directly benefit.
And as we’ve said, strong cash flow, particularly free cash flow, means that we can continue to provide significant cash returns to our shareholders. In the fourth quarter, TI paid $326 million in dividends and repurchased $734 million of our stock for a total return of $1.06 billion.
Our capital management strategy is to return all of our free cash flow to shareholders, except for what we need to repay debt. In the full year 2013, free cash flow was $2.97 billion and we reduced our debt level by $500 million. We returned a total of $4.04 billion to shareholders, or 136% of free cash flow. This return was 54% higher than in 2012. We returned more than our full free cash flow in the year because proceeds from exercises of employee stock options, totaling $1.31 billion in the year, have also been an additional source of cash for the company, all of which was used to repurchase stock.
There was an abnormally high level of exercises in the year due to the stock price performance. Although the exercises were somewhat of a headwind for the share count reduction, we more than offset this with stock repurchases. In the end, we reduced our shares outstanding by 25 million shares, or 2.3%, in 2013 similar to the last couple years. In total, we have reduced our share count by 37% since the beginning of 2005 with our repurchases.
Fundamental to our cash return strategy are our cash management and tax practices. We ended the fourth quarter with $3.83 billion of cash and short-term investments with 82% of that amount owned by TI’s U.S. entities. Because our cash is largely on-shore, it is readily available for a variety of uses, including paying dividends and repurchasing our stock.
TI’s orders declined 10% sequentially and our book-to-bill ratio was 0.94.
Turning to our outlook, we expect TI revenue in the range of $2.83 billion to $3.07 billion in the first quarter. At the middle of this range, revenue would decline 3% sequentially with most of the decline coming from the final step-down in legacy wireless revenue, which is now essentially gone and should not be a factor in the sequential trends after the first quarter. Therefore, if you exclude the legacy wireless revenue from the fourth quarter of 2013, revenue at the middle of this range would be almost even sequentially. If you exclude it from the first quarter of 2013, growth would be 10%
We expect first-quarter earnings per share to be in the range of $0.36 to $0.44, which includes a $0.02 EPS impact from the $30 million of restructuring charges discussed earlier. We expect our effective tax rate in 2014 to increase to 27% and this is the rate you should use in your models for the first quarter. This is about 3 percentage points higher than our 2013 effective tax rate, negatively impacting EPS by $0.02 in the first quarter. This rate is higher due to the expiration of the R&D tax credit at the end of 2013 and our forecast for higher profits in the year. Historically, the R&D tax credit has expired and was later reinstated retroactively to its expiration date.
In summary, we’re encouraged that a lot of hard work at TI over the past few years is producing results. Today, we’re a company firmly rooted in Analog and Embedded Processing – areas that have strong potential for growth and good profits that require low capital investments and, therefore, can generate a lot of cash.
Although much of the heavy lifting associated with the structural improvement at TI is now behind us, our work is not done. The restructuring action we discussed today is a result of an on-going process at TI of review and continuous improvement. This process helps ensure we focus our investments on opportunities that have the best potential for sustainable growth and returns.
With that, I’ll turn it back to Ron.
Thanks, Kevin. Operator, you can now open the lines up for questions. In order to provide as many of you as possible an opportunity to ask your questions, please limit yourself to a single question. After our response, we will provide you an opportunity for an additional follow-up. Operator?
Earnings Call Part 2: